Credit is not a right; it is a privilege, much like a driver’s license. In the case of credit, this privilege is granted by the lender, not the state. Earning the right to credit can be a lengthy process and, for many, it begins in college.
Credit card companies often solicit college students in the hopes they will become cardholders for life. They prey upon college students because of their naiveté regarding revolving credit, as well as their frequently undisciplined purchasing habits. Moreover, lenders believe the college educated individual will attain greater earning power and make more purchases on credit than those who do not have a college education. While this is debatable, one thing is certain—most people begin to earn the right to credit while in college.
Typically, lenders establish low credit limits for these novice cardholders, largely to limit risk, but also as a disciplinary tool to begin the education of the cardholder. This education is basically one of “carrot and stick”. Cardholders who pay on time, remain within their credit limit and use the card with frequency are rewarded with ever larger credit limits. Those who pay late, exceed their limits or use the card infrequently are penalized with exorbitant late charges, have their limits reduced and almost always increased interest rates. In worst case situations, the card is revoked.
All this information, good and bad, is shared with the major credit reporting agencies, TransUnion; Experian; and Equifax.
Establishing Good Credit
College students have a clear advantage in this regard. Credit card companies usually solicit them. For others, the process is more proactive. Obtaining a credit card from a large retailer such as JC Penney, Target or Macys to name a few, is frequently the best way to get a toe in the pool. Expect low credit limits and a few rejections. Secured credit cards are to be avoided as a method of establishing credit. Most, if not all, do not report to the major credit reporting agencies and as a result, your payment record is not routinely accessible to other lenders.
Let the Games Begin
Once a lender has extended credit, the opportunity to build your reputation and your credit score begins. Here are a few tips:
- Always … always, pay on time, preferably a few days before the due date.
- Never use more than 30 to 40 percent of your available credit unless you can pay the balance in full on or before the due date (this helps raise your credit score).
- Whenever possible, pay more than your regularly scheduled minimum payment. Credit card companies craft a minimum payment that can keep you in debt forever. The minimum payments barely cover the interest costs and only a tiny fraction goes to pay down the principal balance on your card.
- Use the card as often as practical mindful of the caveats listed above.
- After your account has been active for a minimum of six months, apply for a card with another retailer. However, do this conservatively. Credit inquires have a negative impact on your credit score. Avoid placing multiple applications for credit within a short time frame.
- Treat each account you open successfully with the same care as the first.
Within 18 months, assuming you have followed the guidelines above, you will begin receiving credit card offers in the mail. Naturally, you will be tempted to take advantage of these offers. Certainly, one or two is acceptable but anything beyond that begets trouble. Choose the offers with the lowest rates. Beware promotional rates that last 6 to 12 months and then increase dramatically. You are better served by a card with a reasonable, static rate. Avoid being caught flat-footed with a high balance that is suddenly subject to an escalated rate of interest.
Keeping Good Credit
Maintaining a good credit profile and a high credit score is essential to your future well-being. A good credit score is like money in the bank but remember it has to be repaid. Here are a few tips for maintaining a high credit score:
- Always pay on or before the due date
- Keep credit card balances no higher than 30 to 40 percent of each card’s credit limit.
- Diversify the types of credit utilized. Use that good credit rating built with credit cards to take out an installment loan with your local bank. A mortgage or an auto loan for example. Not ready for a mortgage or a car—try a 12 month vacation or personal loan.
- Keep a debt to income ratio of 60 percent or less. If you are bringing home $3000 per month, your payment obligations (including rent/mortgage payment and utilities) should total no more than $1800.
- Establish a regular savings habit. Build an emergency fund that can carry you through 6 months of unemployment, ill health or similar catastrophic event.
- Do not make frivolous applications for credit. Each credit application generates an inquiry with one or more of the 3 major credit reporting agencies. As stated earlier: credit inquiries negatively impact your credit score.
- If you have a problem meeting your obligations, contact your lender immediately and seek assistance. Never avoid a creditor. Better yet, build that emergency fund so that you will not face this scenario unprepared.
Following these suggestions will lead you to a high credit score. That high score translates to lower borrowing costs because the best rates are available to the borrowers presenting the least risk.
Responsible management of debt results in reduced stress and a better quality of life. Credit affords you the ability to seize opportunities. If you think you have no need for credit, consider how long it would take you to save for a new car or the home of your dreams.
Credit is a resource and like all resources, it needs to be used wisely.
Andrew Cravenho is the CEO of CBAC LLC & Factor Auction. As a serial entrepreneur, Andrew focuses on helping both small and medium sized businesses take control of their cash flow. Prior to CBAC, Andrew founded an annuity financing company relieving tort victims of financial hardship.